Thinking and Deciding

THE UTILITY OF MONEY 253
Figure 10.2: Graph illustrating the fact that the expected utility of a fair bet is less
than the utility of not betting when the utility function is concave.
the utility of the expected value (3.16) because the slope of the curve is decreasing.
In other words, the curve is concave (as seen from the bottom; convex curves bow
in the other direction). Such concavity of the utility curve explains why, in general,
people are averse to taking risks. This desire to avoid risks is called risk aversion.
Although we shall see in Chapter 17 that there are other causes of risk aversion aside
from the concavity of the utility curve, some concavity is present.
The idea of declining marginal utility makes sense if we think of utility in terms
of goal achievement, as we are doing. If you are poor, you should use money in the
most efficient ways possible to achieve your goals. To do this, you will buy essential
food, clothing, housing, and medical care. If you have much more money, you will
have enough of these things. You will look for ways to use money to achieve other
goals. You may spend money on entertainment, and your expenditures on clothing
and food may be based on fashion and taste rather than survival. These things are
not as important to you per dollar spent as were the other things, or else you would
have bought them first. With still more money, you will find yourself looking harder
for ways to spend the money to achieve your goals. You may have to develop new
goals, such as a taste for expensive wine or philanthropy. Again, if these things were
as important per dollar as other things, you would have bought them first.
Note, though, that the use of declining marginal utility to explain risk aversion
— the aversion to “fair” bets — is a descriptive theory that might not be the whole
story. People may behave as though their decisions were determined by expected
utility, but the “utility” involved in this case is a hypothetical influence on decisions,
not necessarily a true measure of future goal achievement. This kind of “decision